Want to know your customer? Then make sure you understand the labour market.

A transformed labour market…

The scale of change in the UK labour market has confounded economists in recent years. Between 2010 and 2014, the UK created over 1.4m jobs, and today both the number of jobs and the participation rate in the labour market are at record highs. However, it is not just the volume of employment that has changed in the last few years. The transformation of the labour market has been wide-raging and of such a scale to change the consumer market. Consumer oriented companies need to be aware of the impact of the UK’s new labour market on their customers.

…driven by labour supply…

The growth in jobs has been based to a large extent on an increase in labour supply. The scale of immigration into the UK captures the headlines and, as a result, the EU requirement for free movement of labour has become a key element of the negotiations in advance of a referendum on the UK’s membership of the EU. But migration was not the main driver of labour supply growth from 2010 to 2014. The increase in the number of people working to an older age than previously was the most significant driver of growth in the number of people in the workforce. People aged over 65 in work increased from 676,000 in 2008 to 1.2m in late-2015,  an unprecedented increase reflecting changes to pensions, the impact of anti-age discrimination legislation and improved health.

…rather than an increase in pay…

However, this growth in employment has not translated into an equivalent growth in real wages. Between 2009 and 2014, growth in weekly earnings averaged just 1.4%, significantly below pre-crisis rates of growth. There was an increase in the annual rate of increase to 3.3% in May 2015, but this fell back to 2% by the end of 2015. In effect, unemployment is now back to the average observed between 2001 and 2007, but wage growth is only running at half the 4% recorded over that period.

The increase in labour supply cited above is one reason for lower than expected growth in wages, given the UK’s strong growth in employment, but a number of other theories have also been advanced. These include:

• The weakening of the trades unions with an associated reduction in employee bargaining power;
• The recognition by workers of the severity of the financial crisis, leading them to value employment over growth in living standards;
• The flexible nature of the UK labour market which has led to higher number of self-employed and part-time workers with people willing to take whatever employment is on offer;
• Increased costs on employers such as NI and pensions, limiting the resources available for pay rises; and

It is also possible, looking at the high average margins earned in recent years, that employers have chosen to take advantage of these labour market conditions and prioritise profitability ahead of pay rises.

In addition to the effects described above, the EY ITEM Club also suggest, drawing on Bank of England research, that changes in the composition of the workforce, including a shift to lower-skilled and lower paid jobs, may be depressing wage growth currently by 1% per annum.

...with little sign of any change.

An emerging concern is that low inflation is both reducing inflationary expectations among employers and also reducing their ability to put up their market selling prices. As a result, pay rises are being reduced further limiting income growth.

While EY ITEM Club expect real wage growth to begin to increase in 2016 and hold steady thereafter, the message for businesses is clear: the growth in real earnings is not going to be sufficient to offset other squeezes on household incomes and hence there is a need to plan for a world of lower consumer spending growth.

There will be changes in the distribution of income.

Overall income growth is expected to slow after 2016 but this effect will not apply equally to all segments in the consumer market. Understanding the variations in labour market performance by segment will be critical for consumer businesses.

• The National Living Wage (NLA) will boost incomes of the lowest fifth of wage earners more than average. However at the household level, the benefits will be more equally shared as many low income households will have a lower earner eligible to benefit from the NLW.
• Older people will continue to gain from their greater participation in the labour market discussed above and the “Triple Lock” on pensions.
• Households with assets are likely to benefit from higher returns as interest rates rise but indebted households will find their disposable income squeezed.
• Forecast increases in inflation, especially for energy prices, are likely to hit lower income households harder as more of their spending accounted for by energy and food. The introduction of Universal Credit will further squeeze these groups.

A complex consumer landscape

The new labour market is changing the consumer market. Key themes which consumer businesses should consider are:

• Relatively low wage growth means consumers will continue to be highly price sensitive and search for value.
• With high employment and a relatively high chance of finding work after a job loss, we can expect consumers to keep spending a high proportion of their disposable incomes. So savings will stay relatively low, but discretionary spending is more likely to go on purchases with an immediate impact rather than longer -term durable purchases.
• Older people will account for an increasing part of the consumer market, this will boost the spending in areas such as health compared to clothing.
• By contrast, career progression for younger workers is likely to be slower meaning the consumer purchasing life-cycle may well change and people will move to higher consumption levels later in life, if at all.
• Lower income groups should see their disposable income rise faster than will be the case for people in the middle of the income distribution at least in the next one to two years.
• Increased self-employment, part-time work and temporary roles mean credit scoring is likely to become increasing complex as new risk models will be required.

Volumes are likely to grow faster than value this market. The key to success will be to develop the appropriate analysis at a segment and product level, this is a market in which the average provides little insight.

@MarkGregoryEY

markgregoryeconomics.ey.com

EY Economics for Business provides knowledge, analysis and insight to help business leaders understand the economic environments in which they operate, both in the UK and Globally.